Quality Cost Information

Information on the costs of quality helps management evaluate the relative importance of quality problems and thus identify major opportunities for cost reduction. To establish a cost for a quality approach, one must identify the activities that generate cost, measure them, report them

in a meaningful way to managers, and analyze them to identify areas for improvement. This Chapter discusses these activities in greater detail.

Crosby (1984, 15) points out that it is not so much quality, as the lack of it that costs money. The concept of quality costs can be used to launch quality improvement initiatives. In many companies a considerable number of working hours is spent on the inspection of incoming goods and on solving acute quality problems (troubleshooting). The costs involved are often invisible and many companies have absolutely no idea what the lack of quality is costing them (Weele 2005, 193). Making these costs transparent starts with classifying them.

According to Evans and Lindsay (2005, 398-399) among others, quality costs can be divided into four major categories: prevention costs, appraisal costs, internal failure costs, and external failure costs. Prevention costs are investments made to keep nonconforming products from occurring and reaching the customer, including the following specific costs:

• Quality planning costs, such as salaries of individuals associated with quality planning and problem-solving teams, the development of new procedures, new equipment design, and reliability studies

• Process control costs, that include costs spent on analyzing production processes and implementing process control plans

• Information systems costs expended to develop data requirements and measurements • Training and general management costs, including internal and external training,

programs, clerical staff expenses, and miscellaneous supplies.

Appraisal costs are those associated with efforts to ensure conformance to requirements,

generally through measurement and analysis of data to detect nonconformance. Categories of appraisal costs include the following:

• Testing and inspection costs associated with incoming materials, work-in-processes, and finished goods, including equipment costs and salaries

• Instrument maintenance costs due to calibration and repair of measuring instruments • Process measurement and control costs that involve the time spent by workers to gather

and analyze quality measurements.

Internal failure costs are incurred as a result of unsatisfactory quality found before the delivery

of a product to the customer; some examples include the following: • Scrap and rework costs, including material, labor, and overhead

• Cost of corrective action arising from time spent determining the causes of failure and correcting production problems

• Downgrading costs, such as revenue lost when selling a product at a lower price because it does not meet specifications

• Process failures, such as unplanned machine downtime or unplanned equipment repair.

External failure costs occur after poor-quality products reach the customer, specifically;

• Costs due to customer complaints and returns, including rework on returned items, cancelled orders, delayed deliveries, and freight premiums

• Product recall costs and warranty claims, including the cost of repair or replacement as well as associated administrative costs

• Product liability costs, resulting from legal actions and settlements.

The following figure 3-2 illustrates as a summary how the costs of quality described above can be divided into cost of control and cost of failure:

Cost Cost of Control (conformance) Cost of Failure to Control (non conformance) Prevention Costs Appraisal Costs

Internal Failure Costs

External Failure Costs

Figure 3-2 The Costs of Quality

Experts estimate that 60-90 percent of total quality costs result from internal and external failure and are the responsibility of, but not easily controllable by management. One view is that the cost of bad quality can be even 20-30 percent of sales (Tarkkala 2004, lecture 11). A significant part of quality costs is determined in the phase of product design. The earlier the error is noticed, the lower the cost. In some cases a “good enough” principle can be optimal, as the level of 100 percent quality can also be costly. Still, the cost of good quality does not increase as much as quality increases when quality is built-in and integrated into processes (Tarkkala 2004, lecture 11).

An increase in prevention usually generates larger savings in all other cost categories. In a typical scenario, the cost of replacing a poor-quality component in the field might be €500; the cost of replacement after assembly might be €50; the cost of testing and replacement during assembly might be €5; and the cost of changing the design to avoid the problem might be only 50 cents (Evans & Lindsay 2005, 399). Better prevention of poor quality clearly reduces internal failure costs, as fewer defective items are made. External failure costs also decrease. In addition, less appraisal is required, because the products are made correctly the first time. However,

because production is usually viewed in the short term, many managers fail to understand or implement these ideas. (Evans & Lindsay 2005, 399)

In addition, Weele (2005, 193-195) determines the following two types of costs, mainly from the purchasing process view; assessment costs – the costs related to the timely recognition of errors, and correction costs – the costs that result from rectifying mistakes. Assessment costs are incurred to minimize the consequences of errors. Weele says (2005, 195) that over many years the emphasis has shifted from correction to prevention. In an attempt to reduce the total quality costs, preventive quality control has been enhanced. This is illustrated in Figure 3-3 that shows the quality costs model.

Figure 3-3 The Quality Costs Model (Weele 2005, 194)

In addition, Weele (2005, 202) mentions that the cooperation between engineering, purchasing and suppliers offers considerable opportunities for cost minimization. As the product development process advances, the product specifications become more and more fixed, and it therefore becomes more difficult to introduce changes. Furthermore, changes made at a later stage will make the costs rise exponentially.